Right now, more than 70% of the world’s central banks are exploring the merits of central bank digital currencies (CBDCs) — electronic versions of their national fiat. National digital currencies could reduce reliance on commercial banks as the principal interface for money management and increase optionality for consumers, many of whom are beyond the reach of physical bank branches or excluded from the financial system due to poor credit or lack of funds. For CBDCs to open doors to financial inclusion, however, we need universal, open, and user-directed payment networks. For this open peer-to-peer payment infrastructure to develop: 1) governments need to offer regulatory certainty and regulatory sandboxes where projects can be tested, 2) the architects of these networks need to get compliance right from the start, and 3) all parties involved should commit to keeping these solutions open source.
By definition, blockchain technology cuts out middlemen. In relying on networks of users and collective trust, it reduces the need for centralized networks and data storage. This trait made blockchain-powered currencies popular on shadowy parts of the internet, but it has the potential to do something more revolutionary than obscure how money is changing hands: Blockchain-based payment systems can bring the more than 1.7 billion people who are unbanked or underbanked (including 25% of U.S. households), into the formal economy. And in doing so, they can render obsolete the expensive, usurious payment and informal financial services those people use to make ends meet. A generational pandemic makes this challenge all the more urgent, as decades of (admittedly uneven) economic progress are erased.
Right now, more than 70% of the world’s central banks are exploring the merits of central bank digital currencies (CBDCs) — electronic versions of their national fiat. This is a bigger deal than you might think: A national digital currency could reduce reliance on commercial banks as the principal interface for money management and increase optionality for consumers, many of whom are beyond the reach of physical bank branches or excluded from the financial system due to poor credit or lack of funds. Because of the decentralized way that blockchain-based payment systems work, they empower people with the 4S’s of payments, namely how they spend, save, send, and secure their money.
However, for this to work we will need open and interoperable payment rails — universal, open, and user-directed payment networks. Extending the perimeter of the formal economy while lowering the costs of service is not only altruistic, it’s a means to market expansion and lowering risk from the reliance on opaque financial networks.
Ripe for Disruption
It is expensive to be poor, remote, and disconnected, and it has been for a long time. Issues of price, competition, access, and connectivity in banking and payment networks today look similar to telephone networks 50 years ago: At the time, the only people who had reliable access were those who lived in the right country or postal code, and billions of people went without reliable, low-cost communication. Breakthroughs in mobile telephony and broadband, alongside low-cost mobile devices — which, as it happens, more than 1 billion of the 1.7 billion people who are unbanked have access to — made it possible to extend the reach of human connectivity. It is now time to begin connecting those dots, turning an internet-ready mobile phone into a regulated payment endpoint.
An internet-ready mobile phone is the bottom rung of economic mobility. While it’s well established that breakthroughs in mobile banking have improved financial inclusion, blockchain-based payment systems have the potential to reduce costs and improve access even further. The best example of this opportunity are the world’s peer-to-peer remittance cashflows, which totaled more than $700 billion in 2019. The cost and friction-laden process of sending a remittance — in which costs average 7% globally, but can run much higher — leaves a lot to be desired and exacts the heaviest toll on the people who can least afford it. This flow of money is so important that the United Nations has set a target to lower the cost of remittances to 3% as a part of the Sustainable Development Goals.
Achieving this, however, will be elusive short of large-scale, open-source technological modernization of the world’s payment networks. Public-private collaboration and hybrid approaches to CBDCs can ensure the right balance between necessary levels of compliance and innovation are struck in lowering the costs and complexity of cross-border cashflows.
A Way Forward
So, what would an open peer-to-peer payment infrastructure look like? And how would it work with CBDCs? As a first principle, we cannot run a science experiment on the world, and least of all on financially vulnerable people, who may also labor under technological literacy challenges. Practically speaking, there are two ways to achieve this safely: 1) promote regulatory certainty and vigorous promotion of competition around the growing wave of stablecoin projects, and 2) create regulatory sandboxes where various experiments with CBDCs of the wholesale, retail, and hybrid variety can be tested, along with the public-private collaboration that can make last-mile use cases a reality. Just as standardizing global messaging platforms have broadened the base of connectivity by billions of users, the opportunity of compliant blockchain-based payment networks can similarly extend the perimeter of the formal economy and lower the bottom rung of economic mobility, thus completing the financial system, rather than competing with it.
Second, unlike most other disruptive technologies, which evolve rapidly and fix problems along the way, it’s essential for this system to start by getting compliance right, particularly when it comes to satisfying stringent post-9/11 requirements on anti-money laundering, countering the financing of terrorism, and giving illicit actors no place to hide. This includes developing frameworks that can harmonize the regulatory treatment of digital assets around the world, including so-called global stablecoins, which is an area of review by the Financial Stability Board, an international body that monitors the global financial system. One of the key areas of opportunity to extend the perimeter of payments is the development of tiered, “know your customer” (KYC) requirements as well as addressing the global identity gap, in which more than 1 billion people have no nationally issued ID. Here too, the application of blockchain technology, along with biometrics, can improve outcomes for the provision of citizen services (beginning with being counted), including financial access. (The Kiva Protocol project in Sierra Leone offers compelling digital identity directions.)
The third, is that solutions and technologies must be open source. Traditionally, there has been a lack of broad competition for basic services, particularly in payments, and so enabling free development of mobile-native digital wallets — the on-ramps for gaining access to blockchain-based payment systems whether they carry stablecoins or CBDCs — would likely result in broader reach than the traditional world of “brick and mortar” financial access could achieve. Extending the perimeter of the formal economy in a way that balances compliance, risk management and responsible financial services innovation is not about disruption, it is about optionality.
There’s precedent for how central banks, public authorities and the private sector might go about building this kind of infrastructure. Innovation of low-cost, user-directed internet-ready payments has mostly come from Asia, and these innovations are quickly becoming mainstream. Of all the central banks exploring the risks and opportunities of digitizing their national currencies, China’s central bank aims to be the clear winner when it comes to retail, household-level ambition. While most CBDC experimentation is mainly concerned with the wholesale banking layer — between central banks and counterparty private sector banks — China’s focus on the peer-to-peer, user-directed domain, is poised to unlock a wave of digital currency competition.
A System We Need Now
The pandemic has made the utility of this kind of system clear, not just for international payments, but for domestic financial health in the United States. The initial draft of the U.S. CARES Act, which mobilized $2.2 trillion in economic relief and included direct payments to U.S. citizens, called for the creation of a digital dollar and a citizen digital wallet to facilitate real-time direct payments. However short lived this language was in the original bill, the competitiveness, poverty alleviation, and economic gains that can be achieved cannot be overstated. In the U.S., where roughly 51 million Americans have lost their jobs due to Covid-19, more people are forced to rely on payday lending and extortionate credit debt; many of the neediest families waited for many weeks to receive their physical checks. For rural communities and others, the concept of cashing a physical check, much like going to a physical remittance location to pick up money, is not only cumbersome, it is costly and in the midst of a communicable disease outbreak, it is perilous.
Digital currencies and blockchain-based payment systems on their own are not solutions for endemic levels of poverty and financial exclusion. Along with uncommon coalitions, strong governance principles, such as those espoused by the World Economic Forum’s newly-released Presidio Principles, can make a difference in digitizing payments, without imperiling users to fraud, hyper-volatility and lax levels of risk management and compliance, which have plagued many blockchain-based financial services in the past. This now 11-year old technology is coming of age, having survived “crypto winter” and gaining much needed regulatory clarity around the world. What the pandemic underscores in perhaps all aspects of our lives except for payments, is that ubiquitous access to technology — whether teaching millions of students remotely via Zoom – is that the case for open, blockchain-based payment networks and the stablecoins or future CBDCs they may one day carry has also come of age.